Morningstar's Phillips on a scandal's lasting impact

Phillips, managing director at Morningstar, the influential Chicago-based investment research firm, has been even more vocal over the past year as the improper trading scandal snowballed. He's appeared at industry conferences, moderated discussion panels -- even testified before Congress -- delivering a blunt message to any fund firm that will listen: Treat investors fairly, or they will treat you harshly.

In an interview with CBS MarketWatch, Phillips offers advice to investors in scandalized funds who wonder if they'll get any money back, and explains why the best funds offer more than just impressive returns. Listen to the full interview. Here are five questions and his responses:

The mutual fund trading scandal has led to greater scrutiny and reform of fund company practices and policies. Are fund investors better off now than a year ago?

They definitely are. The industry has made some significant steps. There have been good regulatory reforms that are going to give more transparency in the industry, more disclosure, but most importantly, fund companies have seen the huge penalty that some firms have paid for violating the public's trust.

Because of that, this is an industry that absolutely will be on its best behavior for years to come. As ugly as the scandals have been, there are some real positives that are going to come out of them for investors.

Some of the benefits for investors have been more tangential, things that actually weren't related to the initial issues of the scandal. For example, there's now a requirement that the chairperson of a fund board be one of the independent directors. It can't be someone from the money management firm who's also chair of the fund board. In the long run, that's good for investors.

If you look at the root of the scandals, the problem was the absence of checks and balances - not having someone to say "No" to some of the people at these money management firms that came up with these deals with hedge fund managers So re-establishing a firm structure of checks and balances, and having the board set that tone at the very highest level, is something that is a real benefit for investors.

Aren't some companies implicated in the scandal seeing fewer checks come their way?

"If you're an investor in one of the funds that's gotten into trouble, I wouldn't run around thinking that you now hold a lottery ticket."
-- Don Phillips

The ultimate check and balance is the check that comes from investors. You've seen huge amounts of money move out of organizations like Putnam
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Janus
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and Strong that got involved in these scandals.

More than any regulatory action that's going to take place, the message investors sent by voting with their feet is going to be heard at the highest levels of every fund management company. That's an important message. It says that if you violate our trust as investors, we will take our money somewhere else. The market has spoken loudly, moving money away from those firms that have been involved in this, and rewarding firms like American Funds, Vanguard and Fidelity that have not been implicated in the scandals.

What changes still top the regulatory reform list?

The regulators now have their hands full trying to get up to speed on these issues. It's not just market timing. Sarbanes-Oxley has been putting more pressure on fund companies for more disclosure, more signing off at the executive level on financial statements for mutual funds. And of course, the regulators are looking at everything, seeing if there's been market-timing, late trading -- really giving the industry the most thorough scrubbing it's ever got in its history.

The process is going to take another couple of years, but the outcome is that mutual funds will not be a back-burner issue for the regulators. There's a real recognition that this is a vehicle that the public trusts, and is a vehicle that needs to be closely monitored to ensure that the public gets a fair shake.

Will fund investors who were wronged get financial restitution?

It's a difficult challenge, finding out who was wronged, who was in the funds during which time periods, and then calculating what monetary compensation might be appropriate. But some of the firms, like MFS and Putnam, have already appointed people to come in and try to oversee that process.

If you're an investor in one of the funds that's gotten into trouble, I wouldn't run around thinking that you now hold a lottery ticket, that you might get some big windfall. The dollar amounts seem big, but when you realize that these are spread across millions of shareholders, what you're going to see are fairly small amounts of money going back to individual investors. That's appropriate. The reality is that no one saw tens of thousands of dollars taken from their accounts in the wake of these scandals. It's more a situation of a couple of dollars per $1,000 or $10,000 account.

So it's going to be fairly small, and the process is going to be difficult getting it back. The most important thing is the process is working. There is a price to pay for violating the public's trust, and the wheels of justice are moving.

What should investors know about buying funds in this new environment?

Investors are realizing that you need to have a sense of the character of the organization that you're entrusting your money to.

Frankly, mutual funds operate on a very well-lit playing field. There's a history of their actions. Look at the organizations that got into trouble in the scandals and those that avoided that, and you see that the scandals weren't necessarily isolated, one-time instances. There are other ways that pro-investor or anti-investor behavior gets exhibited.

For example, look at organizations that did not get into trouble, groups like Vanguard, Fidelity, American Funds, American Century, T. Rowe Price
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You can say they avoided the scandal, but also these firms have other things in common. For example, none of them launched an Internet fund that would crash and burn on investors.

One of the lessons out of this whole scandal has been that putting the investor first, trying to create a good investor experience, is a winning business practice. Whether that means not launching gimmicky funds that blow up on people, or not cutting side deals with market timers to get additional assets under management, it all boils down to the same root principle: Do you put the investors' interests first, or the interests of the money management firm?

Companies that got into trouble during the scandals put their interests ahead of shareholders. Investors are realizing that you need to look at a fund management organization and say, "Do they have a long history of putting my interests first, or is this a group that seems more concerned about their profitability? People are looking more holistically at the fund companies, not just saying, "Is this a good fund? Does it have good returns?" but, "Is this fund from an organization I can really trust?"

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